NNN Lease vs Gross Lease: Why DST Investors Prefer Triple Net Properties

NNN vs Gross Lease: The Quick Comparison

What Each Lease Type Covers

In a triple net lease, the tenant pays base rent plus three categories of operating expenses: property taxes, building insurance, and common area maintenance. The landlord receives what the industry calls "clean" rental income because these expenses are either paid directly by the tenant or reimbursed to the landlord through a structured pass-through arrangement.

In a gross lease, also called a full-service lease, the tenant pays a single, all-inclusive rent amount. The landlord absorbs all operating expenses from that gross rent: property taxes, insurance, maintenance, utilities, and repairs. The tenant's cost is fixed and predictable, but the landlord bears all expense risk.

Modified gross leases split the difference. The landlord and tenant negotiate which expenses each party will cover. These hybrid structures are common in office buildings and some industrial properties, but they're rare in DST offerings because of the added complexity and administrative burden they create.

The choice between these models is ultimately about risk allocation. With a gross lease, the landlord makes what amounts to a bet on future building operating expenses. The longer the lease term, the greater the difficulty in projecting costs accurately. Macroeconomic factors like inflation, along with property-specific concerns, can be hard to predict over multi-year periods.

Comparison Table for Investors

For DST investors, this distinction matters because it directly affects distribution stability. Understanding lease structure helps you evaluate offerings on an apples-to-apples basis and explains why approximately 80% of DST properties use triple net structures.

Why NNN Creates More Predictable Income for DST Investors

Expense Pass-Through Benefits

The mechanics of expense pass-through in triple net leases create the predictable cash flow that passive investors need. In multi-tenant properties, the landlord calculates total operating expenditures for the entire building, then allocates each tenant's proportional share based on square footage. Tenants receive separate invoices for these costs or reimburse the landlord through monthly payments.

The landlord's rent is "clean" because there are no surprise deductions from cash flow for unexpected property tax increases, insurance premium spikes, or emergency maintenance. When these costs rise due to inflation or market conditions, the tenant absorbs the increase. The landlord's income remains stable and predictable.

This pass-through structure is particularly valuable over long lease terms. A 15-year NNN lease locks in predictable income for the landlord regardless of how taxes, insurance, or maintenance costs evolve. Under a gross lease, that same 15-year commitment would require the landlord to accurately forecast expense inflation across all categories for the entire term. The longer the potential lease term, the greater the difficulty in projecting these costs with any reliability.

Distribution Forecasting Accuracy

For DST sponsors, this predictability translates directly into more reliable distribution projections. When operating expenses are the tenant's responsibility, the variables affecting distributions are limited to factors known at acquisition: tenant creditworthiness, rent escalation schedule, and debt service. All three of these can be evaluated with reasonable precision during underwriting.

A gross lease DST would require sponsors to forecast property taxes, insurance premiums, maintenance costs, and utility expenses over a typical 5-10 year hold period. Recent market data shows why this creates problems. Commercial property insurance costs for multifamily buildings increased more than 75% in real terms from 2019 to 2024, rising from $39 to $68 per unit monthly. Commercial property tax assessments in Colorado increased an average of 26% in the 2023 cycle, the largest jump since records began in 1993. New York City's commercial property tax rate (Class 4) for fiscal year 2024-25 rose by 17 basis points to 10.762%, one of the largest single-year increases in the past two decades.

DST sponsors are legally required under IRS Revenue Ruling 2004-86 to distribute all excess cash to investors after covering operating expenses, debt service, and reserves. They cannot quietly absorb expense overruns from retained earnings. This structural requirement makes accurate expense forecasting critical, which is why NNN properties dominate the DST market.

Investors and lenders prefer the predictable, contractual rent growth that triple net leases provide. The structure makes it easier to model net present value, debt service coverage ratios, and cash flow stability. These factors matter during both the hold period and at disposition or refinancing.

How Gross Lease Properties Create DST Sponsor Risk

Expense Volatility Problems

Three expense categories create particular volatility for gross lease properties: property taxes, insurance premiums, and maintenance costs. All three have been rising faster than the standard 2-4% rent escalators that many gross leases incorporate. Understanding these NNN investment risk factors is essential for evaluating any lease-dependent DST offering.

Property tax reassessments have accelerated in many markets. Jersey City, New Jersey projected a 5-10% tax rate increase in 2025, driven by a 16-20% school tax levy increase and reduced state aid. This follows a 32% increase in 2022 and 6% in 2023. These reassessment cycles are difficult to predict and can significantly impact property-level cash flow.

Insurance costs have surged due to what the industry calls market hardening. Catastrophe losses from hurricanes, wildfires, and floods exceeded actuarial models, forcing insurers to raise premiums. Commercial property insurance rates averaged nearly 12% increases in the fourth quarter of 2023, with even higher increases for properties with loss histories or catastrophe exposure. While rates moderated to 6% by the fourth quarter of 2024, the Council of Insurance Agents and Brokers reported the 31st consecutive quarter of premium increases in the second quarter of 2025.

The impact on property owners is measurable. Federal Reserve research on multifamily properties found that a dollar increase in property insurance costs reduces property owners' net income by approximately 74 cents. Landlords recovered only about 25-40 cents through increased revenues, meaning they absorbed most of the cost increase. For investors in a gross lease structure, that absorbed cost would come directly out of distributions.

Maintenance and utility costs face similar pressures. Rising labor costs, material price inflation, energy expense increases, and regulatory compliance requirements like ESG mandates and accessibility upgrades all push maintenance costs beyond standard escalators. When a gross lease property experiences a major repair or compliance requirement, the cost impacts investor returns immediately.

Why Sponsors Avoid Gross Lease DSTs

Underwriting a DST investment requires projecting cash flows for the expected 5-10 year hold period. With NNN properties, this exercise involves relatively few unknowns. The sponsor evaluates tenant credit quality, reviews the lease terms, assesses market conditions for the eventual sale, and models debt service based on financing terms.

With gross lease properties, the sponsor must layer in expense forecasts across multiple categories, each with its own volatility profile. Property tax projections require understanding local assessment cycles and municipal budget pressures. Insurance projections require evaluating catastrophe exposure, building replacement costs, and insurance market conditions. Maintenance projections require estimating labor inflation, material costs, and potential capital needs.

The reputational risk matters too. When a DST sponsor's Year 1 distribution projections fall short because insurance costs rose faster than expected, investors remember. These initial figures reflect offering-day estimates that can shift as property expenses evolve over the hold period. Repeat business and advisor relationships depend on delivering distributions that track reasonably close to projections. NNN properties provide the expense certainty that makes this possible.

The predictability premium of triple net structures is particularly valuable in the DST context. Investors choosing DST over direct property ownership are specifically seeking passive income without active management burden. Gross lease properties require more active expense management and budgeting, which conflicts with the passive structure that DST investors prefer.

What Expense Pass-Through Means for Your DST Distributions

Reading the Expense Ratio in Offering Documents

Private Placement Memorandums for DST offerings typically exceed 100 pages and include detailed sections on property operations, financial projections, and risk factors. The lease structure is usually disclosed in the Property Description section, while expense assumptions appear in the Financial Projections section.

For an NNN-backed DST, the expense ratio should be minimal. You'll see property management fees, typically 2-4% of gross rent, plus reserve allocations for vacancies and capital needs. Total expenses excluding debt service might run 5-10% of revenue. The rest flows through to debt service and investor distributions.

For a gross lease DST, the expense ratio will be substantially higher. Property taxes alone can consume 15-25% of revenue in high-tax jurisdictions. Insurance might add another 3-8%, especially in coastal or fire-prone areas. Maintenance, utilities, and administrative costs can add another 15-25%. The cumulative impact means that 40-60% of gross revenue might go to expenses before debt service and distributions.

The risk is not just the absolute level of expenses but the uncertainty. If the PPM projects expenses at 45% of revenue but actual expenses run 50%, that five-point difference comes directly out of distributions. Over a 10-year hold, the cumulative impact can be significant.

Look for how the sponsor treats expense escalation in projections. If property taxes are projected flat while the property is in a jurisdiction known for aggressive reassessments, that's a warning sign. If insurance is assumed to grow at 2% annually while the broader market is experiencing high single-digit increases, the projections may prove optimistic.

Realistic Distribution Expectations

DST distributions occur monthly in most offerings, though frequency can vary based on the trust structure. The distributions come from net cash flow after all expenses, debt service, and reserve allocations. Distributions are not guaranteed and depend on the underlying property's operating performance. Actual amounts can fluctuate based on occupancy, tenant payments, and expense levels.

In an NNN-backed DST, this calculation is straightforward. The tenant pays base rent plus expense reimbursements. The trust deducts management fees and debt service, sets aside required reserves, and distributes the remainder pro-rata to investors. Because the expense component is largely predictable, distributions tend to track close to initial projections.

In a gross lease DST, the calculation involves more variables. Revenue comes from gross rent, but the trust must pay all operating expenses before determining distributable cash. As those expenses rise over time, the amount available for distribution can decline even if gross rents remain stable or increase slightly.

Reserve funds provide some cushion, but they're limited. DST sponsors typically allocate 3-10% of equity for reserves at closing, and they may build additional reserves from cash flow. These reserves must be invested in short-term, low-risk instruments under IRS rules. They're meant for temporary shortfalls, not to subsidize distributions over multi-year expense increases.

The mechanical cash flow path matters for understanding distribution stability. Tenant rent payments flow to the property, operating expenses are deducted (minimal in NNN, substantial in gross leases), debt service is paid, reserves are funded, and the remainder distributes to investors based on their ownership percentage. Each step in that chain where costs can vary creates potential distribution volatility.

What to Look for in DST Offering Documents

Lease Type Disclosure

The Property Description section of a PPM should explicitly state the lease structure. Look for clear labels: NNN, NN, Gross, Modified Gross, or Absolute NNN. Each structure allocates expenses differently.

An absolute NNN lease, sometimes called a bondable lease, makes the tenant responsible for all expenses including major structural repairs like roof replacement. This is the cleanest income stream for passive investors because essentially all costs pass through to the tenant. The landlord's role becomes purely administrative.

Standard triple net leases pass through taxes, insurance, and maintenance but may leave some structural items with the landlord. The lease document will specify these exceptions. Most DST offerings feature standard or absolute NNN leases, but make sure to check the specific terms.

Pay attention to lease term and remaining term. A property with 12 years remaining on a 15-year lease provides income stability for most of a typical DST hold period. A property with 3 years remaining faces re-leasing risk that could affect later-year distributions.

Review rent escalation provisions. Some leases include fixed annual increases, others tie escalations to CPI, and some have periodic market resets. Fixed escalators provide predictability. CPI-linked escalators protect against inflation but create some year-to-year variability. Market resets introduce more uncertainty.

Expense Assumptions and Reserves

Compare projected expenses to historical actuals when possible. If the PPM shows that property taxes were $150,000 last year but projects $155,000 for year one and flat thereafter, ask why. Most taxing jurisdictions reassess properties on cycles, and commercial property values have been rising in many markets.

Insurance projections deserve particular scrutiny given recent market conditions. The Council of Insurance Agents and Brokers documented 31 consecutive quarters of commercial premium increases through mid-2025. Properties in coastal areas, wildfire zones, or tornado alleys face higher premiums and more volatility. Flat or low-growth insurance projections in these locations may prove optimistic.

Reserve adequacy depends on the property type, tenant quality, and lease structure. An NNN property with an investment-grade tenant on a 15-year lease might require minimal reserves. A gross lease property in a high-cost jurisdiction with moderate tenant credit might need substantial reserves to buffer expense volatility.

Some modified gross leases include expense caps that limit how much the tenant reimburses. If expenses exceed the cap, the excess cost falls to the landlord. For a DST, that means the excess comes out of investor distributions. These caps are relatively rare but worth checking for.

Direct NNN Ownership vs DST: Making the Right Choice

Direct ownership of triple net properties requires substantial capital, typically $1 million or more for quality assets. Net lease investment activity reached approximately $48.1 billion for the year ending in the third quarter of 2025, up 24% year-over-year, reflecting strong institutional demand. Single-tenant net lease properties with strong credit tenants trade at premium prices that put them out of reach for most individual investors.

Beyond capital requirements, direct ownership involves lease negotiation, due diligence, financing arrangements, property management oversight, and eventual disposition. Each step requires time, expertise, and resources. Tenant relationships must be managed over 10-20 year lease terms. When a lease expires or a tenant defaults, the owner must handle re-leasing, including broker relationships, lease negotiations, and potential tenant improvement costs.

DST structures provide access to institutional-quality NNN properties with investment minimums of $50,000 to $100,000. The sponsor handles all property operations, tenant relationships, and eventual disposition. Investors own beneficial interests in the trust, which qualify as like-kind property under IRS Revenue Ruling 2004-86 for 1031 exchange purposes.

The trade-off is control and liquidity. Direct owners negotiate their own lease terms, set their own disposition timing, and make all property-level decisions. DST investors accept the sponsor's decisions on these matters in exchange for passive ownership and lower capital requirements. DST interests are illiquid securities with no guaranteed secondary market, and investors should be prepared to hold for the full investment period, which typically ranges from five to ten years. Sponsor fees and offering costs also reduce net returns compared to direct ownership.

For investors seeking portfolio diversification, DST structures offer particular advantages. A $500,000 investment can be spread across five DST offerings with different tenants, property types, and geographic locations. Achieving similar diversification through direct ownership would require several million dollars and significantly more complexity.

The gross versus NNN distinction applies in both structures, but it matters more for DST investors who lack the ability to actively manage expenses. Direct owners can sometimes negotiate expense reductions, change vendors, or make improvements that lower operating costs. DST investors receive distributions based on how the sponsor manages these issues. Choosing NNN-backed DSTs reduces exposure to expense management decisions.

Frequently Asked Questions

Next Steps for DST Investors

Understanding lease structure is foundational to evaluating DST offerings. Triple net properties dominate the DST market because they create the predictable income that passive investors need for retirement planning and income goals. The expense pass-through structure aligns with the passive ownership model that makes DST investments attractive for 1031 exchanges and portfolio diversification.

When reviewing specific offerings, focus on the lease structure, remaining lease term, tenant credit quality, and expense projections. Compare these factors across multiple offerings to understand how different properties and sponsors approach risk and income stability. Properties with strong credit tenants, long remaining lease terms, and true triple net structures provide the most predictable income profile.

The choice between direct ownership and DST investment depends on your capital position, time availability, expertise level, and desire for control versus passive income. Both paths can provide access to triple net properties, but they serve different investor profiles and goals. Because lease structures affect both distributions and tax treatment, consulting with a CPA or tax advisor who understands your specific situation is an important step before committing to any offering. Understanding the lease structure fundamentals discussed here helps you make that choice with clarity about the trade-offs involved.

Every investor's situation is different, and the right structure depends on your goals, tax position, and risk tolerance. The Anchor1031 team can help you evaluate specific options with that context in mind. Reach us at (502) 556-1031 or schedule a call at anchor1031.com.

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